U.S. has to move people from construction and consumer goods to export and import-competing goods. (8M?)

Foreigners have to move people from export industry into construction and consumer goods. (40M?)

Why can't the current configuration go on forever? Consider China, currently at $250B a year (12% of Chinese GDP) with foreign exchange reserves of $1T (50% of Chinese GDP). In a decade, at the current pace, foreign exchange reserves of $4.5T (110% of future Chinese GDP). Losses on foreign exchange reserve portfolio: to buy dollars at $1=8RMB and then to sell them at $1=4RMB is expensive.

What happens just before foreign central banks abandon their dollar-purchase programs?

One-equation economics assumes that certain economic quantities are fixed in stone, examines one equation--usually an accounting identity--and concludes that somebody else's preferred policies will be ineffective and counterproductive. It does so by ignoring the fact that one of the aims or effects of the somebody else's policies will be to change the values of the economic quantities that are--by assumption and only by assumption--claimed to be fixed in stone.

Here's Stanford's Michael Spence. The one equation is the international savings-investment identity. The quantities assumed fixed are domestic saving and investment:

If our savings rate is stubbornly stuck below our investment rate, and if China does allow its currency to revalue over time, then we will simply run a deficit with another collection of countries, and from a domestic point of view, nothing much will have changed. Except that we won't have this subject to discuss with China anymore.

"If our savings rate is stubbornly stuck below our investment rate." If. If. If. As Michael Mussa likes to say in these circumstances: if my grandmother had wheels, she would be a bus.

If China's central bank ceases buying its $200 billion a year of dollar denominated assets, and if nothing shocks the behavior of other central bank or collection of private foreigners, two things will happen: (1) the value of the value of the dollar will fall, and (2) U.S. interest rates will rise. The fall in the value of the dollar will boost U.S. exports and diminish U.S. imports, and the trade deficit will shrink. And--as long as the Federal Reserve is successful in avoiding recession--the rise in interest rates will reduce investment inside the United States and also lower asset values, which will make homeowners and investors feel poorer and increase their savings. It will thus reduce the gap between savings and investment, and so diminish the capital inflow.

Only if investment is stubbornly unresponsive to changes in the price of hiring capital and if savings is stubbornly unresponsive to housing and financial market wealth will Spence's "if" be true. But does Spence argue that investment is unresponsive? Does he argue that savings are unresponsive? Does he argue that there will be some other shock to the economy--that, for example, the Federal Reserve will fail to maintain full employment and thus that savings will fall because of recessions? No. He says "if." And he only says "if."

Now Mike Spence might argue that the Wall Street Journal does not give him much space, and that even if the Wall Street Journal gave him more space his readers would not give him more time. He might argue that he has to compress and simplify his argument: make it "clearer than truth." He might say that he is not a philosopher discoursing to fellow philosophers walking outside in the sunlight, but rather addressing the ignorant chained in the underground cave, and that it is his job to cast shadows on the wall that will lead those chained underground to support the policies they would support if they could understand the issues, if they were philosophers strolling in the sunlight.

And, Spence might say, it is his job to use whatever means are necessary to keep his readers from supporting destructive policies. He has to cast a shadow on the wall of the cave to get them thinking that tariffs and quotas on imports from China are not a way to reduce America's trade deficit and boost overall fand manufacturing employment.

Point taken: whatever effects (and there would be some) tariffs and quotas on imports from China would have on the level and distribution of employment in the U.S. would be accompanied by much more destructive blowback consequences. Tariffs and and quotas on imports from China are not a good idea. Getting China to boost consumption and domestic absorption would be a good idea. Closing the U.S. budget deficit would be a good idea. Boosting U.S. private savings would be a good idea. But doing none of those and doing tariffs and quotas instead? Not a good idea.

However, lowering the level of the debate by asserting that the Chinese government's purchase of $200 billion a year of dollar-denominated bonds doesn't affect the U.S. trade balance--that is not a good idea either. Those of us who walk outside in the sunlight and see reality as it is have a moral responsibility to bring others out of the cave: to raise the level of the debate, rather than to focus on casting handshadows that ultimately cannot but mislead.

Greg Mankiw's Blog: Spence on the Trade Deficit: Economist Michael Spence (erstwhile Harvard prof) has a nice piece on the U.S. trade deficit and the Chinese exchange rate in today's Wall Street Journal. His bottom line:it would be useful if we stopped pretending or alleging that China's exchange-rate policies are the root cause of our trade deficit. If our savings rate is stubbornly stuck below our investment rate, and if China does allow its currency to revalue over time, then we will simply run a deficit with another collection of countries, and from a domestic point of view, nothing much will have changed. Except that we won't have this subject to discuss with China anymore.

The linkage among saving, investment, and the trade deficit is a topic that will feature prominently in ec 10 this spring.

We understand why we import crude oil--ExxonMobil's rigs can pump more oil at other places on the earth than they could here. We understand why we import autos--as a former owner of a Chevy Citation and a Ford Taurus, I understand that especially well. There are lots of goods that people in other countries can make more productively than we can here in America--can make with fewer workers and less capital. But why do we import goods like apparel, where U.S. producers are the most productive in the world?

An answer:

The principle of comparative advantage...

You can be more productive than somebody else at a task, but it can still be not worth your time

Micro examples: I'm a d---ed good xeroxer.

The morality of comparative advantage:*

Is this ethical?
You're taking advantage of somebody else's lousy bargaining position...
You're giving them opportunities they wouldn't otherwise have had...
The case of Cuba: market exchange is inherently unjust and destructive and the U.S. trade embargo against Cuba is the source of the island's impoverishment

Micro Trade Market Failures

Externalities:

Environment

Labor standards

Communities of technological and craft practice

People who don't know what they really need

All cases in which the maxim "if it's profitable, it's good" is false...

Division of Labor:

From Adam Smith (1776), An Inquiry into the Nature and Causes of the Wealth of Nations:

Observe the accommodation of the most common artificer or day-labourer in a civilized and thriving country, and you will perceive that the number of people... employed in procuring him this accommodation, exceeds all computation. The woollen coat... is the produce of the joint labour of... [t]he shepherd, the sorter of the wool, the wool-comber or carder, the dyer, the scribbler, the spinner, the weaver, the fuller, the dresser, with many others....

How many merchants and carriers, besides, must have been employed in transporting the materials from some of those workmen to others who often live in a very distant part of the country! how much commerce and navigation in particular, how many ship-builders, sailors, sail-makers, rope-makers, must have been employed in order to bring together the different drugs made use of by the dyer, which often come from the remotest corners of the world! What a variety of labour too is necessary in order to produce the tools of the meanest of those workmen! To say nothing of such complicated machines as the ship of the sailor, the mill of the fuller, or even the loom of the weaver.... The miner, the builder of the furnace for smelting the ore, the feller of the timber, the burner of the charcoal to be made use of in the smelting-house, the brick-maker, the brick-layer, the workmen who attend the furnace, the mill-wright, the forger, the smith, must all of them join their different arts in order to produce them....

This division of labour, from which so many advantages are derived, is not originally the effect of any human wisdom, which foresees and intends that general opulence to which it gives occasion. It is the necessary, though very slow and gradual, consequence of a certain propensity in human nature... to truck, barter, and exchange one thing for another.

Whether this propensity be one of those original principles in human nature... it belongs not to our present subject to enquire. It is common to all men, and to be found in no other race of animals.... Nobody ever saw a dog make a fair and deliberate exchange of one bone for another with another dog....

When an animal wants to obtain something either of a man or of another animal, it has no other means of persuasion but to gain the favour of those whose service it requires. A puppy fawns upon its dam, and a spaniel endeavours by a thousand attractions to engage the attention of its master who is at dinner, when it wants to be fed by him. Man sometimes uses the same arts with his brethren, and when he has no other means of engaging them to act according to his inclinations, endeavours by every servile and fawning attention to obtain their good will.

He has not time, however, to do this upon every occasion. In civilized society he stands at all times in need of the cooperation and assistance of great multitudes, while his whole life is scarce sufficient to gain the friendship of a few persons.... [M]an has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love... it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages...

Extent of the Market:

From Adam Smith (1776), An Inquiry into the Nature and Causes of the Wealth of Nations:

As it is the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited by... the extent of the market. When the market is very small, no person can have any encouragement to dedicate himself entirely to one employment, for want of the power to exchange all that surplus part of the produce... for such parts of the produce of other men's labour as he has occasion for.

There are some sorts of industry... which can be carried on no where but in a great town.... In the lone houses and very small villages which are scattered about in so desert a country as the Highlands of Scotland, every farmer must be butcher, baker and brewer for his own family. In such situations we can scarce expect to find even a smith, a carpenter, or a mason, within less than twenty miles of another of the same trade. The scattered families that live at eight or ten miles distance from the nearest of them, must learn to perform themselves a great number of little pieces of work, for which, in more populous countries, they would call in the assistanc.... A country carpenter... is not only a carpenter, but a joiner, a cabinet maker, and even a carver in wood, as well as a wheelwright, a ploughwright, a cart and waggon maker.... It is impossible there should be such a trade as even that of a nailer in the remote and inland parts of the Highlands of Scotland....

As by means of water-carriage a more extensive market is opened to every sort of industry than what land-carriage alone can afford it, so it is upon the sea-coast, and along the banks of navigable rivers, that industry of every kind naturally begins to subdivide and improve itself...